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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

For The Fiscal Year Ended June 30, 2004

For the transition period from              to             

Commission file number 000-25147

Internet America, Inc.

(Name of registrant as specified in its charter)

Registrant’s telephone number: (214) 861-2500

Securities registered pursuant to Section 12(b) of the Exchange Act:

(Not applicable)

Securities registered pursuant to Section 12(g) of the Exchange Act:

Common Stock, Par Value $.01 Per Share

(Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).    Yes  ¨    No  x

Based on the closing price of the registrant’s Common Stock on December 31, 2003, the aggregate market value of the Common Stock held by non-affiliates of the registrant is $7,278,107. Solely for the purposes of this calculation, all executive officers and directors of the registrant and all shareholders reporting beneficial ownership of more then 5% of the registrant’s Common Stock are considered to be affiliates.

The number of shares of Common Stock outstanding as of September 24, 2004 was 10,458,012.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement for the Annual Meeting of Shareholders to be held in December 2004 to be filed within 120 days after the end of our fiscal year, are incorporated by reference into Part III, Items 10-14 of this Form 10-K.

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This Report on Form 10-K contains forward-looking statements that involve risks and uncertainties. Actual results, performance or achievements, or industry results, may be materially different from those described in the forward-looking statements due to a number of risk factors. Such risks and uncertainties include those set forth under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Form 10-K. See also Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Safe Harbor Statement.”

PART I

Item 1. Business

General

Internet America is an Internet service provider (“ISP”) that provides a wide array of Internet services tailored to meet the needs of individual and business subscribers. As of June 30, 2004, we served approximately 58,000 active subscribers. Internet America was incorporated in Texas in 1995 and currently has operations in Texas. Our new growth strategy is to expand Internet America’s customer base by acquiring dialup ISPs in markets surrounding our major market cities. Additionally we intend to gain new customers and improve retention of existing customers through improved marketing, increased broadband service availability and the introduction of new value-added services.

Elements of our growth strategy include:

Development of Value-Added Revenue Streams. We continue to develop value-added revenue streams such as dedicated broadband connectivity, news access and Web hosting. In addition, we continue to evaluate other value-added service opportunities such as Internet telephony. We believe that a user dense, regional customer base provides an excellent platform for the introduction of new value-added services, taking advantage of existing brand awareness and economies of scale.

Cost-Effective Development of Network Infrastructure. We deploy network infrastructure in a disciplined manner to achieve substantial economies of scope and scale. We have been consolidating our Texas operations and have realized substantial efficiencies from this consolidation. With our “Virtual POP” architecture, we can provide local access services quickly and efficiently without investing in additional physical infrastructure. See “— Infrastructure,” below.

Creative Use of Advertising to Maintain the Internet America Brand. We have used primarily outdoor billboard, radio and print media advertising. We are currently developing marketing using these media and new ones in more rural markets.

See Item 6, Selected Consolidated Financial Data contained in Part II to this report on Form 10-K for comparative information regarding, among other things, revenue, net income (loss) and total assets.

Services

We offer Internet services tailored to meet the needs of both individual and business subscribers. Our primary service offerings are broadband and dial-up Internet access, as well as related value-added services. For our business subscribers, we offer dedicated high speed Internet access, Web hosting, co-location and other business related services. Our services are offered in several different packages to provide subscribers a broad range of choices to satisfy their Internet needs. The majority of our consumer subscribers have month-to-month subscriptions and the majority of our business customers are under service contracts for a term. We bill most consumer subscribers through automatic charges to their credit cards or bank accounts, and we bill most of our business customers by monthly invoices. We offer discounts on almost all of our services for subscribers who prepay for a longer term.

High Speed Connectivity; DSL Services. We offer broadband connectivity for business and consumers, including 64k/128k Integrated Service Digital Network (ISDN) access, 1.5M Asymmetrical Digital Subscriber Lines (ADSL), fractional to full T-1, DS-3 level connectivity and wireless connectivity. Our DSL products provide high-speed Internet access over existing telephone lines, and may allow subscribers to simultaneously use a single telephone line for voice service and for access to the Internet. DSL provides an “always on” connection thereby removing wait times associated with dialing into a network. The DSL products offer our residential and business subscribers a cost-effective way to substantially increase the speed at which they access the Internet.

Dial-Up Internet Access. Our most popular dial-up Internet access package includes basic Internet access and related

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Internet applications such as World Wide Web browsing, e-mail, file transfer protocol (FTP), and USENET news access. Available value-added services include multiple e-mail mailboxes, national roaming services, personalized e-mail addresses, personal Web sites and enhanced USENET news access.

USENET. Our Airnews.net product provides access to Internet America’s newsgroup services for subscribers of other Internet services and on a wholesale basis to other businesses or ISPs.

Web Services. We offer Web hosting through our Airweb.net service for businesses and other organizations that wish to create their own World Wide Web sites without maintaining their own Web servers and high-speed Internet connections. Web hosting subscribers are responsible for building their own Web sites and then uploading the pages to an Internet America server. This Web hosting service features state-of-the-art servers for high speed and reliability, a high quality connection to the Internet, specialized customer support and advanced services features, such as secure transactions and site usage reports.

Customer Care

Our goal of 100% customer satisfaction begins with providing superior systems and network performance. We focus on scalability, reliability and speed in the technical design and maintenance of our systems. In addition to the provision of superior systems and network performance, we emphasize high quality customer care and technical support. We strive to retain our subscribers by prompt response to customer problems via telephone, email and newsgroups.

Individuals accessing the Internet have many different operating system, hardware and network configurations, coupled with varying levels of computer sophistication. Consequently, our customer care department must be able to efficiently and effectively address:

We had approximately 49 customer care employees at June 30, 2004. Customer care is available to subscribers 24-hours-a-day, 7-days-a-week. The customer care department is organized in tiers designed to respond to varying types of support needs. In addition to diagnosing and resolving subscribers’ technical problems, our customer care department answers questions about account status and billing information, provisions new product requests and provides configuration information.

We maintain a comprehensive description of our customer care services on our Web site, as well as troubleshooting tips and configuration information. Additionally, we offer our subscribers free educational classes, which are held monthly in our Dallas office. Subscribers can also obtain recorded system and network status reports at any time and review extensive system and network performance on the World Wide Web.

Marketing

Our marketing strategy is to differentiate our offerings along three major axes: 1. Service Availability; 2. Product differentiation, and; 3. Unique, creative advertising and execution.

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To date in 2004, Internet America has successfully deployed several new products and services to enhance our portfolio and to increase customer loyalty.

Fax-2-Email – This provides our customers the ability to receive faxes directly in their email inbox. We offer two versions of the service, one with a limit of 50 received faxes and another with unlimited usage. The product has been well received in the marketplace as we have added over 650 customers in just the first 9 months of service.

Family Safe – In keeping with our view of providing our customers a safe Internet experience, we launched a new product called Family Safe which offers customers a specialized software package to customize restrictions of access to certain websites and also to track the viewing habits of others who might abuse the use of the Internet

@Backup – In 2004 Internet America partnered with @Backup to develop a new online storage solution for our customers. The product was released in early summer and has seen many customers utilize the new online storage solution to better manage their need to safely backup their data. Our @Backup solution is simple, cost effective and allows a customer to set-it-and-forget-it.

WAP Mail – In 2004 we released a tool to allow our customers to receive their email messages using any web enabled browser that is currently available via most cellular telephones. By using this browser, customers are able to check their email messages and also respond or send new messages, all from their cellular phone. This service is free to all Internet America customers.

Air Fetch – Also in 2004, we developed and implemented a new service called Air Fetch to enable our customers to check their non-Internet America email accounts from a local Internet America website, to provide better management of all of a customer’s email accounts. An example would be if a customer had abc@ev1.net and abc@airmail.net, by signing up with the Air fetch service from Internet America, a customer could check all of their email accounts in one place using Air Fetch. Because of the nature of these products, there can be no assurance that all of these products will generate significant revenue for the Company in the future.

We are developing several exciting new products for our portfolio that will further enhance the customer value delivered for Internet America subscribers.

Future anticipated products include the following:

Voice over Internet Protocol (VOIP) – A new service in the marketplace that is quickly gaining acceptance with the likes of AT&T, Time Warner Cable, and several other communications companies. Internet America plans to launch a VOIP offering in the very near future. Our standalone VOIP product will be a competitive phone offering and will provide us the ability to create new bundles of services for our customers.

FAX America – Capitalizing on the successful roll out in early 2004 of Fax delivery directly to a customer’s inbox, later this year we will roll out a new FAX SEND and RECEIVE product that will be branded with the FAX America name. FAX America will allow us to enhance the current RECEIVE only service by adding SEND capabilities. Our product will not only be versatile in its functionality but also be very price competitive allowing us to aggressively market FAX America to our customers.

Family Mail America – Playing upon the idea that we are a net-enabled Internet service provider and furthering the idea that our products are customizable to the market, we are rolling out a new personalized email service called Family Mail America. This product will allow a customer to have their own EMAIL domain i.e. thejonesfamily.com and assign as many names as they wish to the email to personalize their Internet mail experience.

Expanded DSL coverage – With the increase in broadband adoption in the marketplace and with Internet America continuing to expand our product set to better serve the high-speed broadband marketplace, we will continue to look for new ways to expand our DSL offering and to further our footprint in the market. We are looking at new partnerships that will facilitate this need and allow us to better serve the markets we operate in.

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Broadband over Powerline (BPL) – Internet America is exploring a new technology on the horizon called Broadband over Powerline to help provide expanded broadband coverage to customers. BPL is a technology that allows a customer to easily plug in a modem into their electrical outlet and receive high-speed Internet. While still in the development phase, Internet America is beginning to work on testing such a service and hopes to create a total product solution in the next 3 – 6 months that will allow us expand our broadband options.

Wi-Fi – Internet America is moving into the Wireless Internet Access marketplace in rural markets and testing new Wireless solutions that should provide wireless internet connectivity at very competitive prices in high density markets. Our desire is to find a new way to offer the 802.11 and other wireless technologies in selected markets. Our first launch of a high density market is slated for late 2004.

Our advertising strategy relies on the utilization of several different mediums for customer acquisition activity, including but not limited to, Radio, Outdoor, Paid Search on Search Engine portals such as Yahoo and Google, paid on-line banner advertising on technology focused websites, print communications, and others. The number and type of mediums rotates on a regular basis and we anticipate that will continue to be the case as work to improve the efficiencies in our advertising communications strategy.

Infrastructure

Our network provides subscribers with local dial-up and broadband (DSL) access in all major metropolitan areas of Texas, as well as dial-up access in many tier 2 and tier 3 cities. Our systems and network infrastructure are designed to provide reliability and speed. Reliability is achieved through redundancy in mission critical systems that minimize the number of single points of failure. Speed is achieved through clustered systems, diverse network architecture, multi-peered Internet backbone connections and aggressive load balancing.

Physical and Virtual POPs. Subscribers dial a local phone number and connect to one of our points of presence (POPs), consisting of inbound telephone lines, modems and related computer equipment. The POPs are either facilities owned by Internet America or “Virtual POPs” owned by telecommunication companies. Virtual POP architecture allows us to provide local access services without deploying additional physical infrastructure. The Virtual POP architecture enables subscribers to dial a local phone number and connect to a modem owned and housed by a telecommunications provider. The subscriber’s data call is then routed across leased lines to our internal network. Unlike simply leasing network capacity from a third-party provider, the Virtual POP architecture allows us to maintain substantial control over quality of service and capacity. The benefits of this architecture include substantially reduced capital expenditures and reduced exposure to technological obsolescence. In addition, when entering new markets, the Virtual POP architecture allows us to more precisely match capacity needs to actual sales in that market.

Internal Network Infrastructure. Subscribers enter our network from either the physical POP or Virtual POP. Our primary internal network is designed to maximize sustained high-speed traffic and provide both resiliency to failure and redundancy. Our facilities are powered by a computer controlled uninterruptible power supply that provides battery backup, surge protection and power conditioning. Automatic onsite diesel generators provide power for prolonged power outages.

We also maintain a Network Operations Control Center (“NOCC”) in Dallas, which is staffed 24 hours a day. The NOCC is responsible for monitoring the status of all networking facilities, components, applications and equipment deployed throughout our infrastructure. The NOCC is responsible for operational communications among internal departments and is also responsible for communication with external service providers. Sophisticated historical and statistical analysis software used in the NOCC provides data about the quality of service most subscribers are experiencing, as well as information to help control costs by purchasing additional bandwidth and services only when needed.

We maintain our applications on a variety of systems from a number of vendors. The major applications, such as e-mail and newsgroup access services, utilize a network of servers which are connected directly to our network backbone through high-availability network routers. We deploy PC style hardware in clusters for distributing the load of other applications and providing fault-tolerance against application failure. These distributed applications are housed on low cost, easily obtainable components with minimal interdependency.

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Management Information Systems. Our MIS department uses a near real-time customer database, billing and flow-through fulfillment system (“CMS”) to handle all customer contact and billing information for the services we provide. CMS maintains access controls for the authentication servers and various applications. The system also creates customer invoices and automatically processes credit card charges and automatic check handling. During the year ended June 30, 2004, our MIS department successfully migrated our PDQ subsidiary and our NeoSoft subsidiary database management systems to CMS. We are also enhancing CMS to automate many additional functions and provide improved financial, marketing and management reporting.

Technology and Development

Although we do not focus a material amount of resources on creating new technologies, we continuously evaluate new technologies and applications for possible introduction or incorporation into our services. High-speed connectivity is essential to the commercially viable deployment of new, value-added services such as Internet telephony, particularly VoIP, video and audio programming distribution and other high-bandwidth, low-latency applications. We believe that we are well positioned to efficiently market and deploy our broadband products and other new, value-added services due to the high density of our subscriber base.

Proprietary Rights

General. We believe that our success is more dependent upon technical, marketing and customer service expertise than upon our proprietary rights. However, our success and ability to compete are dependent in part upon proprietary rights. We primarily rely on copyright and trademark laws. “Internet America,” the Internet America logo, “1-800-Be-A-Geek,” “PDQ.Net,” “ExpressLane DSL,” “Airmail.net,” “Airnews.net,” “Airscreen.net” and “Airweb.net” are registered service marks of Internet America or its subsidiaries.

There can be no assurance that the steps we take will be adequate to prevent the misappropriation of our technology or that our competitors will not independently develop technologies and services that are substantially equivalent or superior to ours.

Competition

The Internet services market is extremely competitive. There are no substantial barriers to entry, and we expect that competition will continue to intensify. We believe that the primary competitive factors determining success in this market include pricing, access speed, a reputation for reliability and service, effective customer support, and access to capital. Our current and prospective competitors include many large companies that have substantially greater market presence and financial, technical, marketing and other resources than we have. Increased competition for users of Internet services may result in lower subscriber growth rates or continued subscriber loss. Competitors may charge less than we do, causing us to reduce or preventing us from raising our fees. As a result, our business and revenues may suffer. We currently compete or expect to compete with the following types of Internet access providers:

The market for broadband services is extremely competitive. The markets we serve have been flooded with DSL, cable and wireless offers from our competitors, some of which have greater resources than we have and are able to offer their products at lower prices than we offer. We have to rely on local loop providers with which we compete to provide DSL services to our customers. These providers have been exerting pressure on independent ISPs, including raising prices and changing billing relationships, all of which puts us at a competitive disadvantage. Many local loop providers have consolidated or failed, causing fewer choices for us to offer to our customers. Furthermore, other methods of broadband delivery which we do not currently offer, such as cable or wireless transmission, may be more successful than DSL.

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We expect to continue to experience competition from numerous telecommunications providers, including the traditional telecommunications carriers, local exchange carriers and traditional long-distance companies, many of which have greater coverage and market presence, as well as substantial financial, technical and marketing resources. These telecommunications providers may have the ability to bundle Internet access with basic voice services, which may make it difficult for us to compete effectively. We also face competition from companies that provide connections to consumers’ homes, including national and regional telecommunications providers, cable companies, electric utility companies and terrestrial and satellite wireless communications companies. For example, cable television operators offer Internet access through their cable facilities at significantly faster rates than existing analog modem speeds. These companies include Internet access in the basic bundle of services, or offer such access for a nominal additional charge, and could prevent us from delivering Internet access through wire and cable connections owned by these competitors.

Our competition is likely to continue increasing, especially as diversified telecommunications and media companies begin providing Internet services, ISPs consolidate into larger more competitive companies and new competitors enter the Internet services market. The ability of these competitors or others to enter into business combinations, strategic alliances or joint ventures or to bundle services and products with Internet access could put us at a significant competitive disadvantage.

Government Regulation

We are not currently subject to direct regulation by the Federal Communications Commission or any other agency, other than regulations applicable to businesses and public companies generally. The FCC classifies Internet access providers as “information service providers” rather than regulated “telecommunications providers” under the 1996 Telecommunications Act. As such, we are not subject to regulations that apply to telephone companies and similar carriers. However, we provide Internet access through transmissions over public telephone lines, which transmissions are governed by regulations and policies of the FCC establishing charges, terms and conditions. Changes in the FCC’s policies relating to the classification of telecommunications services and information services could have a material adverse effect on our business. If we became classified as a provider of telecommunications services, regulations could affect the charges we pay to connect to the local telephone network, could impede our ability to compete for broadband customers and could cause us to have to increase prices for our services.

For example, Internet access providers currently are not required to pay carrier access charges. If Internet communications become regulated by the FCC in the same manner as traditional telecommunications services, access fees similar to those paid by long distance telephone carriers could be imposed on Internet access providers. Access fees could increase the cost of the Internet to users, most of whom currently enjoy unlimited, flat-fee usage. This in turn could slow the growth of the Internet and cause an adverse effect on our business. The FCC also does not currently require ISPs to contribute to the Universal Service Fund (although most telecommunications providers charge these fees to their customers, including us). Telecommunications carriers are actively seeking reconsideration or reversal of the FCC decisions regarding universal service as well as carrier access fees. In addition, a reclassification of Internet services as telecommunications services would jeopardize Internet access providers’ current right to nondiscriminatory access to the telephone lines owned by incumbent local telephone companies for use for broadband services. We cannot predict the outcome of FCC proceedings or other federal legislation, but if adopted, these and other regulatory actions could have a material adverse effect on our business, financial condition and results of operation. Finally, any change in the FCC’s policy of not regulating Internet access providers may cause states to regulate aspects of our business as telecommunications services.

The FCC also does not currently regulate the use of cable infrastructure for Internet access as a telecommunications service or cable service. This classification will likely protect cable modem service providers from regulation, including regulations requiring open access to cable infrastructure. Although some cable operators are voluntarily providing access to competing service providers, the FCC’s classifications decrease our potential to provide Internet access services via the cable television infrastructure.

Due to the increasing popularity and use of the Internet, it is possible that additional laws, regulations, or legal precedent may be adopted with respect to the Internet, covering issues such as content, privacy, pricing, unsolicited email, encryption standards, consumer protection, electronic commerce, taxation, copyright infringement and other intellectual property issues. We cannot predict the impact, if any, that any future legal or regulatory changes or developments may have on our business, financial condition and results of operations. Changes in the legal or regulatory environment relating to the Internet access industry, including changes that directly or indirectly affect telecommunication costs or increase the likelihood or scope of competition from regional telephone companies, cable operators or others, could have a material adverse effect on our business, financial condition and results of operations.

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Employees

As of June 30, 2004, we employed approximately 87 people, almost all of whom are full-time employees. None of our current employees are represented by a labor organization, and we consider employee relations to be good.

Executive Officers (as of September 22, 2004)

The following table sets forth certain information concerning our executive officers as of September 22, 2004.

William E. Ladin, Jr. Mr. Ladin became CEO and Chairman of the Board of Directors in September 2003 after serving as Vice Chairman of the Board since January 2000. He joined us in connection with our acquisition of PDQ.Net, a Houston-based Internet service provider that Mr. Ladin formed in 1997. Mr. Ladin served as chief executive officer of PDQ.Net until its acquisition by Internet America. Ladin was instrumental in growing PDQ.Net into Houston’s largest independent Internet service provider, known for providing quality connectivity at an affordable price. Prior to forming PDQ.Net, Ladin was a successful entrepreneur having been involved with founding and/or operating a number of publicly held companies, including The ForeFront Group, a Houston based Internet company; ComputerCraft, a chain of micro-computer retail stores that grew to 65 stores during his management; Mobil Communications Corporation, known as MobilCom, a national paging company that was sold to Bell South in 1988; Lifemark, a hospital company that merged with AMI in 1984; and First of Texas Incorporated, a Houston based investment banking firm.

David E. Allard joined us in April 2003 as Executive Vice President - Strategic Implementation. Mr. Allard previously was employed by Primedia Workplace Learning, where as Chief Operating Officer, he created and managed new products and strategies to increase revenue and profitability. As Executive Vice President and Chief Financial Officer of E-Train from 1997 to 2000, Mr. Allard administered major business combinations and developed a business turnaround plan to create significant savings. From 1992 to 1996, Mr. Allard was Senior Vice President – Business Development of Westcott Communications, Inc., where he managed product lines and business combinations. Mr. Allard is a certified public accountant and a former partner of Farmer and Allard, P.C.

Item 2. Properties

Our corporate headquarters are located in downtown Dallas, Texas at One Dallas Center, 350 N. St. Paul, Suite 3000, where all executive functions exist. We lease approximately 30,000 square feet in Dallas, Texas and approximately 5,600 square feet in Houston, Texas. All systems, sales and technical support functions take place in our Dallas and Houston facilities. We do not own any real estate. We believe that all of our facilities are adequately maintained and suitable for their present use.

Item 3. Legal Proceedings

We are involved from time to time in routine disputes and legal proceedings occurring in the ordinary course of business. Management believes these matters, individually and in the aggregate, are immaterial to our financial condition, results of operations and cash flows.

Item 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of our security holders during the fourth quarter of fiscal 2004.

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PART II

Item 5. Market For Registrant’s Common Stock and Related Stockholder Matters

Our common stock began trading on the Nasdaq National Market on December 10, 1998 under the symbol “GEEK.” Before that date, there was no established public trading market for our common stock. Our common stock was delisted effective August 15, 2001 and currently trades on the OTC Bulletin Board under the symbol GEEK.OB. The following table shows the high and low bid quotations per share of the common stock for the periods indicated as reported on the OTC Bulletin Board. These over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.

At September 21, 2004, there were 240 holders of record of our common stock. The last reported sale price of the common stock on the OTC Bulletin Board on September 21, 2004 was $0.59 per share.

We have neither declared nor paid any cash dividends on our capital stock and do not anticipate paying cash dividends in the foreseeable future. Our current policy is to retain any earnings in order to finance the expansion of our operations. Our board of directors will determine future declaration and payment of dividends, if any, in light of the then-current conditions they deem relevant.

Information regarding securities authorized for issuance under the Company’s equity compensation plans is incorporated by reference to Item 12 of this Form 10-K, which in turn incorporated by reference a section of the Company’s definitive proxy statement.

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Item 6. Selected Financial Data

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following is a discussion of the financial condition and results of operations of Internet America, Inc. for the years ending June 30, 2004, 2003 and 2002. This discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this report.

Safe Harbor Statement

Certain statements contained in this Form 10-K constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Exchange Act. These statements, identified by words such as “anticipate,” “believe,” “estimate,” “should,” “expect” and similar expressions, include our expectations and objectives regarding our future financial position, operating results and business strategy. These statements reflect the current views of management with respect to future events and are subject to risks, uncertainties and other factors that may cause our actual results, performance or achievements, or industry results, to be materially different from and worse than those described in the forward-looking statements. Such risks and uncertainties include those set forth in this section and elsewhere in this Form 10-K. We do not intend to update the forward-looking information to reflect actual results or changes in the factors affecting such forward-looking information. We intend the forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in the Private Securities Litigation Reform Act of 1995.

These risks include, without limitation, that the Company (1) will not increase revenues or improve EBITDA, profitability or product margins, (2) will not retain or grow its customer base, including its broadband and commercial services customers, (3) will not continue to achieve operating efficiencies, and (4) will be adversely affected by dependence on network infrastructure, telecommunications carriers and other suppliers, by regulatory changes and by general competitive, economic and business conditions.

Overview

Internet America is an Internet service provider (“ISP”) that provides a wide array of Internet services tailored to meet the needs of individual and business subscribers. We afford our subscribers a high quality Internet experience with fast, reliable service and responsive customer care. As of June 30, 2004, we served approximately 58,000 active subscribers in the southwestern United States, primarily in Texas.

The Company has experienced a continued decline in revenue since the fiscal year ended June 30, 2001. This decline is primarily as a result of the loss of dial-up connectivity customers. The loss of these dial-up customers is primarily attributed to customers moving to broadband connectivity services. The Company did not have an adequate, competitive broadband solution for a majority of their customers and, as result, customers moved to other providers. Additionally, as the Company had experienced significant operating losses through fiscal 2002, it substantially reduced its sales and marketing efforts to provide for positive operating cash flows as it examined other strategic alternatives for the Company’s future growth. Currently the Company has started new initiatives for new products and the acquisition of new sources for broadband alternatives such as wireless connectivity and broadband over power lines.

The growth of the Internet has resulted in increased competition for existing services and increased demand for new products and services. Increases in demand and a surge in Internet users have fostered an increase in the number of ISPs providing access to the Internet. Our competitors advertise in our existing markets with aggressive new promotions or offers of free Internet access.

Recent technological developments have facilitated the increased adoption of broadband access via mechanisms such as cable, fixed/mobile wireless, and copper pair allowing voice, video, and data to occur simultaneously over one connection. The emergence of low-cost broadband solutions will significantly impact the ability of many ISPs to compete. We are committed to offering cost effective broadband solutions to individuals and businesses. We believe it is essential to offer commercially viable, new, value-added services such as Internet telephony, particularly Voice Over Internet Protocol (VoIP), video and audio programming distribution and other applications. We believe we are well positioned to efficiently market and deploy these new products due to the high density of our subscriber base. In addition, we are well positioned to offer add on services to new and existing dial-up customers, such as increased speed, help-desk services, virus protection, spam filtering and other applications.

Given the high level of competition in the industry for new subscribers, we will be more selective with investing in direct response advertising. We plan to concentrate our direct response advertising more heavily in markets where we have established branding than in new markets.

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Our amortization expense increased through fiscal year 2002 as the costs of purchased subscriber bases were written off. No amortization expense was recorded for the twelve months ended June 30, 2004 and no amortization expense will be recorded for future periods because all of the Company’s intangible assets, excluding goodwill, were fully amortized by June 30, 2002. In addition, the Company adopted Statement of Financial Accounting Standards Board No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”) as of July 1, 2002, accordingly, our goodwill is no longer amortized.

We have an accumulated deficit of $51.8 million at June 30, 2004 and have had annual operating losses since inception until the last two fiscal years as a result of building network infrastructure and rapidly increasing market share.

Statement of Operations

Internet services revenue is derived from individual dial-up Internet access, including analog and ISDN access, DSL access, dedicated connectivity, bulk dial-up access, Web hosting services, and value-added services, such as multiple e-mail boxes and personalized e-mail addresses.

A brief description of each element of our operating expenses follows:

Connectivity and operations expenses consist primarily of setup costs for new subscribers, telecommunication costs, and wages of network operations and customer support personnel. Connectivity costs include (i) fees paid to telephone companies for subscribers’ dial-up connections to our network and (ii) fees paid to backbone providers for connections from our network to the Internet.

Sales and marketing expenses consist primarily of creative and production costs, costs of media placement, management salaries and call center wages. Advertising costs are expensed as incurred.

General and administrative expenses consist primarily of administrative salaries, professional services, rent and other general business expenses.

Depreciation and amortization are computed using the straight line method over the estimated useful lives of the assets. Data communications equipment, computers, data servers and office equipment are depreciated over three years. We depreciate furniture, fixtures and leasehold improvements over five years. For fiscal years prior and ending June 30, 2002, purchased subscriber bases and related goodwill were amortized over 30 to 36 months. Effective July 1, 2002, it was determined that the Company’s goodwill would not be amortized due to the adoption of SFAS 142.

Our business is not subject to any significant seasonal influences.

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Results of Operations

Year Ended June 30, 2004 Compared to June 30, 2003

The following table shows financial data for the years ended June 30, 2004 and 2003. Operating results for any period are not necessarily indicative of results for any future period. Dollar amounts are shown in thousands (except per share data).

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Total revenue. Total revenue decreased by $5.5 million, or 31.4%, to $12.0 million in fiscal 2004 from $17.5 million in fiscal 2003. The Company’s subscriber count decreased by 20,000, or 25.6%, to 58,000 as of June 30, 2004 compared to 78,000 as of June 30, 2003. The decrease in the subscriber count is attributable to tightened credit policies and procedures and customer attrition exceeding our rate of new sales.

Connectivity and operations. Connectivity and operations expenses decreased by $2.3 million, or 27.1%, to $6.4 million for fiscal 2004 from $8.7 million for fiscal 2003. Approximately $1.5 million of the decrease relates to the consolidation of internet and telephone connections and circuits to more closely align with demand, as well as the renegotiation of contracts with several of our major telecom vendors. The remaining decrease relates primarily to staff reductions. As a percentage of total revenue, connectivity and operations expense was 52.3% for fiscal 2004 compared to 49.9% for fiscal 2003, primarily due to the decrease in revenues.

Sales and marketing. Sales and marketing expenses increased by $200,000, or 41.1%, to $687,000 for fiscal 2004 from $487,000 for the prior fiscal year. The increase relates to an additional $286,000 in advertising dollars spent in fiscal 2004 compared to fiscal 2003 as a result of the Company’s increased marketing efforts including billboard and print advertising in two of the Company’s major markets, Dallas and Houston. Reductions in sales and marketing staffing totaling approximately $86,000 during fiscal 2004 compared to fiscal 2003 reduced the net increase in sales and marketing costs.

General and administrative. General and administrative expenses decreased by $1.1 million, or 26.3%, to $3.2 million for fiscal 2004 from $4.3 million for fiscal 2003. The decrease relates primarily to decreases in personnel costs and office expenses. General and administrative personnel costs decreased by $1.2 million or 50.5%, to $1.0 million for the year ended June 30, 2004, compared to $2.2 million for the year ended June 30, 2003 primarily as a result of the Company’s staff reductions. Office expense decreased by $189,000, or 24.7%, to $577,000 for the year ended June 30, 2004 compared to $766,000 for the year ended June 30, 2003, primarily as a result of the consolidation of the Houston offices, the renegotiation of the Dallas office lease as well as decreases in employee benefits related to the reduction in staff.

Provision for bad debt expense. Provision for bad debt expense decreased by $526,000, or 74.8%, to $177,000 for fiscal 2004 from $703,000 for fiscal 2003. Provision for bad debt expense as a percentage of revenue decreased to 1.5 % in fiscal 2004 from 4.0% in the prior fiscal year due to tightened credit policies and procedures. As of June 30, 2004, we are fully reserved for all customer accounts that are at least 90 days old.

Depreciation and amortization. Depreciation and amortization expense decreased by $416,000, or 62.2%, to $253,000 for fiscal 2004 from $669,000 for fiscal 2003. The decrease is due primarily to certain property and equipment becoming fully depreciated.

Lawsuit expense (gain). Lawsuit expense of $332,000 in fiscal 2004 relates to settlements entered into by the Company with one former non-employee director and two former employees.

Interest income (expense), net. Net interest decreased by $712,000, or 116.0%, to a net interest income of $98,000 in fiscal 2004 compared to net interest expense of $614,000 for fiscal 2003. During fiscal 2004 the Company recorded no interest expense, but did record interest income of approximately $62,000 related to interest earned on an overpayment of sales tax during 2000, interest income on an outstanding note receivable from a former CEO of approximately $5,000 and approximately $31,000 related to interest earned on the Company’s cash balances.

During fiscal 2003, in addition to interest on indebtedness and interest earned on cash balances, the Company recorded $150,000 in interest expense related to the fair value of an option purchased from former non-employee director, Mr. William Hunt as well as interest expense of approximately $240,000 on an adverse judgment related to certain litigation settled by the Company in May of 2003.

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Index to Financial Statements

Year Ended June 30, 2003 Compared to June 30, 2002

The following table shows financial data for the years ended June 30, 2003 and 2002. Operating results for any period are not necessarily indicative of results for any future period. Dollar amounts are shown in thousands (except per share data).

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Index to Financial Statements

Total revenue. Total revenue decreased by $8.0 million, or 31.4%, to $17.5 million in fiscal 2003 from $25.5 million in fiscal 2002. The Company’s subscriber count decreased by 42,000, or 35.0%, to 78,000 as of June 30, 2003 compared to 120,000 as of June 30, 2002. The decrease in the subscriber count is attributable to tightened credit policies and procedures, normal customer attrition exceeding our rate of new sales, and the loss of DSL customers due to the bankruptcy of one of our DSL providers. Our subscriber count also decreased due to the consolidation of several billing systems which eliminated counting multiple products sold to one customer, which did not impact revenues.

Connectivity and operations. Connectivity and operations expenses decreased by $4.0 million, or 31.5%, to $8.7 million for fiscal 2003 from $12.7 million for fiscal 2002. The decrease is primarily due to the consolidation of internet and telephone connections and circuits which was a result of decreased revenues. As a percentage of total revenue, connectivity and operations expenses remained constant at 49.9% for the current fiscal year compared to the prior fiscal year.

Sales and marketing. Sales and marketing expenses decreased by $212,000, or 30.3%, to $487,000 for fiscal 2003 from $699,000 for the prior fiscal year. The majority of the decrease relates to a reduction of personnel costs. Sales and marketing expense as a percentage of revenue remained fairly constant at 2.8% for the current fiscal year compared to 2.7% for the prior fiscal year. In the future, we plan to increase sales and marketing expenditures to the extent we can develop cost effective and efficient techniques in the sale of new and existing products.

General and administrative. General and administrative expenses decreased by $1.0 million, or 18.9%, to $4.3 million for fiscal 2003 from $5.3 million for fiscal 2002. The decrease is mainly related to our overall effort in cost reduction including the consolidation of operations. General and administrative expenses as a percentage of total revenue increased to 24.7% in fiscal 2003 from 20.9% in the prior year.

Provision for bad debt expense. Provision for bad debt expense decreased by $1.6 million, or 69.6%, to $0.7 million for fiscal 2003 from $2.3 million for fiscal 2002. Provision for bad debt expense as a percentage of revenue decreased to 4.0 % in fiscal 2003 from 8.8% in the prior fiscal year due to tightened credit policies and procedures. As of June 30, 2003, we were fully reserved for all customer accounts that are at least 90 days old.

Depreciation and amortization. Depreciation and amortization expense decreased significantly by $14.8 million, or 95.5%, to $0.7 million for fiscal 2003 from $15.5 million for fiscal 2002. Due to the adoption of SFAS 142, we recorded no amortization expense for the fiscal 2003. Amortization expense was $14.1 million for fiscal 2002.

Accrued lawsuit gain. The $321,000 gain for fiscal year 2003 represents the excess reserve related to the settlement of the Carradine lawsuit which was offset with legal fees related to the lawsuit. See Item 3, Legal Proceedings.

Interest expense, net. Interest expense increased $76,000, or 14.1%, to $614,000 for fiscal 2003 from $538,000 for fiscal 2002. We recorded $150,000 in interest expense for fiscal 2003 related to the fair value of the option which was purchased from Mr. Hunt. We recorded post judgment interest related to an adverse judgment in the Carradine litigation of $240,000 for fiscal year 2003 compared to $320,000 for fiscal year 2002, a decrease of $80,000.

Liquidity and Capital Resources

We have financed our operations to date primarily through (i) cash flows from operations, (ii) public and private sales of equity securities and (iii) loans from shareholders and third parties.

Net cash provided by or (used in) operations totaled $178,000 for fiscal 2004 compared to $(762,000) for fiscal 2003. Net cash provided by operating activities for fiscal 2004 consisted primarily of net income of $1.1 million plus non-cash operating items totaling $568,000 offset by a $1.1 reduction in accounts payable and accrued expenses and a decrease in deferred revenue of $481,000. Net cash used in operating activities for fiscal 2003 was negatively impacted by the $3.25 million Carradine lawsuit settlement and the $761,000 decrease in deferred revenue. Deferred revenue decreased as a result of the decrease in our subscriber count.

Net cash used in investing activities was $140,000 for fiscal 2004 compared to $143,000 for fiscal 2003, and consisted of equipment lease buyouts and routine purchases of property and equipment to expand and upgrade our network.

For fiscal 2004, net cash used in financing activities totaled $136,000 compared to $29,000 for fiscal 2003. Net cash used for financing activities for fiscal 2004 consisted principally of the purchase of the stock option from William O. Hunt (as discussed below) for $150,000.

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On September 18, 2001, we entered into an agreement with a former director, William O. Hunt, in which Mr. Hunt collateralized an appeal bond with a letter of credit in the approximate amount of $3.3 million to appeal a judgment entered against the Company, Mr. Hunt and a former executive officer of the Company. Internet America initially collateralized a portion of the appeal bond by placing approximately $200,000 in short term certificates of deposit required to be in place for the duration of the appeal. In August 2002, Internet America increased the amount of these short-term certificates of deposit by approximately $332,000 in order to significantly reduce the annual premium of the appeal bond. There were one time transaction costs to post this appeal bond. Annual recurring financing costs for this bond were up to $316,000. In connection with this agreement, we granted Mr. Hunt a security interest in our assets other than accounts receivable.

On May 6, 2003, the Company settled the judgment described in the preceding paragraph. As part of the settlement agreement, the Company made a cash payment of $3.25 million to the plaintiff. The judgment of approximately $3.3 million had been on appeal by both parties since 2001, with the Company seeking to reduce the amount in full and the plaintiff to increase the amount to approximately $5.5 million, plus post-judgment interest. Just before the settlement, post-judgment interest accruing at a rate of 10% per annum had increased the liability to over $3.7 million. As a result of the settlement, the appeal bond was released and, under the financing agreement with Mr. Hunt, Mr. Hunt received an option to purchase approximately 9,428,571 shares of common stock. We purchased the option from Mr. Hunt for $150,000 on September 3, 2003.

We estimate that cash on hand of $1.9 million at June 30, 2004 along with anticipated cash flow from operations will be sufficient for meeting our working capital needs for fiscal 2005 with regard to continuing operations in existing markets. However, if customer losses continue, we may begin experiencing liquidity issues. Additional financing will be required to fund acquisitions or expansion into new markets.

If additional capital financing arrangements, including public or private sales of debt or equity securities, or additional borrowings from commercial banks, are insufficient or unavailable, or if we experience shortfalls in anticipated revenues or increases in anticipated expenses, we will modify our operations and growth strategies to match available funding. In such case, it is likely that our advertising expenditures would be downscaled to a level where positive cash flows are generated from operations. We have no long term advertising commitments.

In addition, the following are contractual cash obligations due by fiscal year for the Company as of June 30, 2004: